Market & Regulatory Perspectives Ahead of Proxy Season
In this week’s thought leadership, we cover the market and regulatory forces influencing this year’s proxy season.
Setting the Stage
As we enter proxy season, a topic that has captivated the investment community ahead of the annual general meeting is none other than one of our favorite acronyms – ESG (FCF is right up there, too!).
While not a new topic, we have seen a consistent shift across the capital markets of companies and investors finding more common ground, with issuers proactively taking steps to address ESG measures through the adoption of new goals and clear initiatives.
That said, attitudes toward ESG remain varied across stakeholder groups; 2022 saw an uptick in “ESG-backlash,” a response which, according to some investors, stemmed from overly prescriptive shareholder proposals, as well as policies that weren’t considered particularly relevant to a company’s business. In addition, through the course of 2021-2022, 18 states passed “anti-ESG” legislation in an effort to curtail state-funded investment arms from participating in ESG investing activities or from adopting certain ESG policies, such as decreasing investment in carbon-intensive sectors.
As the macroeconomy shifts and U.S. politics heats up ahead of the 2024 presidential election, it’s no surprise that institutional investor focus on ESG has increased over the past year, with the future of the field now coming into focus.
Before diving into our emerging proxy trends coverage next week, below, we’ve provided an overview of some of the key forces influencing 2023’s proxy season.
Buy-side Perspectives Point toward Enhanced Focus on ESG
Despite public pushback among certain groups, our proprietary Voice of Investor® research demonstrates ESG has been firmly catalyzed within the investor community, with each measure seeing increased emphasis as an investment factor by at least 20% over a four-year period.
Moreover, while AUM inflows have been throttled after a record 2021 and amid the Great Reset of 2022, sustainable assets1 under management as a percentage of total managed assets has been on a steady rise across the globe, increasing from 4.6% to 7.1% over the same four-year timeframe.
The increase in focus and funding has translated into an uptick of ESG-related shareholder proposals in 2022 relative to the prior proxy period, particularly concerning Environmental and Social (E&S) matters.
With concerns over proposals being too prescriptive, as well as political motivations entering the fray, we expect the trend of overall declining support on shareholder proposals to continue this year.
Regulatory Efforts Continue to Mount
In November 2021, the SEC issued a bulletin which altered the way the department enforces issuers’ ability to exclude certain shareholder proposals from the proxy, particularly regarding E&S topics.
Since then, regulators worldwide have continued to churn out new guidelines on ESG-related disclosures, practices, and mandates, most notably the March 2022 climate-related disclosure proposal from the SEC which has since resided in public commentary purgatory.
As it relates to this year’s proxy, several rules will now be in effect or under greater scrutiny:
- New pay vs. performance disclosure: After support for Say on Pay fell to 86% in 2022 – the lowest in 5 years3 – this year, new pay versus performance rules will require companies to provide new details on the compensation paid to the CEO and other NEOs. Among other things, the requirements assert that companies must provide a Pay vs. Performance Table, detailing executives’ compensation while situated against selected financial performance measures for the three most recently completed fiscal years. In sum, companies are now required to link executive pay with financial performance measures that are deemed “most important” by the issuer.
- Universal proxy cards: The SEC amended the federal proxy rules to require the use of universal proxy cards by management and shareholders soliciting proxy votes for their own candidates in contested director elections. With the new rules in place, it will likely become easier for activists to add their nominees to company ballots. Given the current economic environment, along with activist interests in seeking short-term gains, we expect to see increased activism specifically targeted at directors.
- Board leadership and risk oversight disclosure: Item 407(h) of Regulation S-K requires disclosure in proxy statements of the Board’s leadership structure, why it’s appropriate, and “the extent of the Board’s role in risk oversight, such as how it administers its oversight function and the effect that it has on the Board’s leadership structure.” In recent months, the SEC’s Division of Corporation Finance has stepped up oversight, sending comment letters to companies asking that they expand their disclosure in future filings, telegraphing the need for more enhanced disclosure ahead of peak proxy season.
Proxy Advisors Double Down on ESG Expectations
In addition to the new regulatory requirements, proxy advisory firms Glass Lewis and ISS issued updated 2023 guidance, primarily focused on three key measures:
- Increased and enhanced disclosure of climate risks: Advisors are placing additional emphasis on “those companies whose own GHG emissions represent a financially material risk”4 aligning with the Task Force on Climate-related Financial Disclosures (TCFD) framework, as well as demonstrating continued progress toward GHG reduction targets, including more robust targets and regular disclosure of progress toward goals.
- Increased Board oversight and accountability: Both firms expect greater Board oversight and accountability on climate and social issues. In general, the advisors assert they will recommend voting against companies that fail to provide explicit disclosure concerning the Board’s role in overseeing environmental and social issues, which may come in the form of specific director responsibilities, the entire Board, a separate committee, or combined with the responsibilities of an appointed committee.
- Detailed DEI disclosure: Across a variety of measures, proxy advisors are taking aim at diversity, equity, and inclusion initiatives. Both Glass Lewis and ISS recommend Board gender diversity, with the former transitioning from a fixed numerical approach to a percentage-based approach (i.e., 30% gender diverse), and the latter extending their Board gender diversity policy of at least one woman to all U.S. companies and foreign private issuers. As well, both firms are encouraging at least one director be from an underrepresented community and/or be racially/ethnically diverse. Notably, both encourage public disclosure of director diversity, something the Nasdaq has required since 2021.
With investors placing increasing importance on ESG as a part of their investment thesis and 56% believing companies that integrate ESG into their business strategy will outperform over the long term5, we’ve been advising our clients to embrace Environmental, Social, and Governance issues, with the knowledge that they serve as an opportunity to drive differentiated, sustainable, and, most importantly, profitable growth.
In light of shifting markets, regulatory tailwinds, and ahead of your annual general meeting, consider the following selected strategies and best practices:
- Make a clear case for the effectiveness of the Board’s makeup today and update / develop a skills and composition matrix: With the implementation of universal proxy cards, activist efforts may result in more pronounced influence on director elections than in previous years. As well, regulatory and advisory firm pressures continue to point to the need for enhanced Board composition and associated disclosure. To combat this, clearly explain and detail why the current slate of directors is uniquely qualified; what skill sets and lived experiences does each Board member bring to the table; and how their individual contributions enhance the Board’s ability to operate effectively. Showcase these skills, backgrounds, and responsibilities in a matrix, published within the 10-K and ESG report, on the company website, and within other appropriate investor channels such as the investor presentation. Keep in mind, this need not apply only to Board members; with new pay vs. performance disclosure rules targeting executive compensation, showcasing executive level skill sets that may be flying underappreciated by the investment community will only serve as an additional benefit.
Skills and Composition Matrix Best in Class Example: Domino’s (DPZ), $11.1B, Consumer Disc.
- Develop a communication strategy for how to respond to ESG skepticism: Should you interact with a skeptical investor or other stakeholder, have a plan in place to respond in a manner that is consistent with the company’s holistic ESG business strategy and value creation efforts. Important questions to ask internally include: Could each key decision maker articulate that strategy today? Is the ESG strategy part and parcel of the corporate strategy? As recent trends have shown, “anti-ESG” proposals and sentiment have risen over the past year and are likely to be confronted during proxy season or in conversations with certain investors. Clearly articulating why these efforts contribute toward long-term profitability is a muscle that executives and directors will need to build and strengthen.
- Refresh or conduct an ESG materiality assessment: Now more than ever, it’s important to provide a compelling case to the market about why resources are being spent on the issues that stakeholders care most about. An ESG materiality assessment is a tool that can be used to identify and best prioritize the ESG issues that are most critical to your organization, while also serving as an opportunity to exercise stakeholder engagement. By bringing investors into the fold and clearly laying out how the company intends to earn a return on such initiatives, investors not only gain a greater understanding of focus areas and efforts, but also increased confidence in management’s capital allocation discipline.
In Closing
Next week, we’ll be back with an in-depth analysis of preliminary proxy trends.
- Morningstar classifies funds as sustainable if “In the prospectus or other regulatory filings it is described as focusing on sustainability, impact investing, or environmental, social or governance (ESG) factors.”
- ESGAUGE, The Conference Board
- National Association of Corporate Directors
- Glass Lewis, with Glass Lewis and ISS both referring to companies identified within the Climate 100+ Focus Group
- Corbin Advisors